The capping of the deductibility of retirement contributions for tax : a comparison between South Africa and developed countries

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The capping of the deductibility of retirement contributions for

tax: A comparison between South Africa and developed

countries

CJ du Plessis

22093052

Dissertation submitted in

partial

fulfillment of the requirements

for the degree

Master of Commerce in South African and

International Taxation

at the Potchefstroom Campus of the

North-West University

Supervisor:

Prof Dr K Coetzee

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ABSTRACT

In the Taxation Laws Amendment Act of 2013 the deductibility of retirement contributions for taxation purposes in South Africa was changed. This changed the way in which pension fund contributions, provident fund contributions and retirement annuity fund contributions are treated for tax purposes. These adjustments include the capping of the amount of retirement contributions that will be deductible for income tax purposes. The cap amounts to R350 000 annually.

In this study the amended South African tax consequences, specifically the capping of retirement contributions, are compared to the tax legislation of developed countries, which include Australia, Denmark and Ireland. These countries are selected from the Melbourne Mercer Global Pension Index (MMGPI) as this index lists the best countries in terms of three sub-indices. The countries selected have the highest index amounts for the adequacy sub-index. This sub-index takes into consideration the tax consequences of retirement savings. As such, the South African tax consequences are compared to the best pension systems in the world according to the MMGPI to determine whether the South African tax legislation is in line with of those of developed countries.

Quantitative analyses are performed to determine the income tax consequences in all selected countries for individuals in different income categories. Based on the findings in this study, it can be reasonably concluded that, for each of the selected countries some adverse tax implications will result from contributions above the imposed limits. With the introduction of the cap of contributions to the South African tax legislation, South African taxpayers will now be subject to similar limits as in the selected developed countries. Therefore the legislation is now more in line with the legislation of the aforementioned countries.

KEYWORDS: Developed countries, undeveloped countries, pension fund contributions,

provident fund contributions, retirement annuity fund contributions, retirement savings, capped amount.

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UITTREKSEL

In die Wysigingswet op Belastingwette van 2013 is the aftrekbaarheid van bydraes tot aftreefondse vir belastingdoeleindes gewysig. Hierdie verandering het die belastinggevolge ten opsigte van die aftrekbaarheid van pensioenfondsbydraes, voorsorgfondsbydraes sowel as uittredingsannuïteitsfondsbydraes, gewysig. Hierdie wysigings sluit die beperking van die bydraes vir belastingdoeleindes afgetrek kan word, in. Die beperking is ‘n jaarlikse bedrag van R350 000.

In hierdie studie word die gewysigde belastinggevolge in Suid-Afrika met die belastinggevolge in ontwikkelde lande vergelyk. Daar word spesifiek gefokus op die beperking (R350 000) wat ingestel is. Die ontwikkelde lande wat in die studie gebruik is, is Australië, Denemarke en Ierland. Hierdie lande is geselekteer van die “Melbourne Mercer Global Pension Index” (MMGPI), ‘n indeks wat lande lys op grond van drie sub-indekse. Die geselekteerde lande het die hoogste indekse gebaseer op die toereikendheid van hul pensioenstelsels. Hierdie sub-indeks neem die belastinggevolge in ag. Die Suid-Afrikaanse belastinggevolge word dus vergelyk met die beste pensioenstelsels in die wêreld volgens die MMGPI. Hierdie vergelyking bepaal of die Suid-Afrikaanse belastinggevolge in lyn is met die gevolge in ontwikkelde lande.

Kwantitatiewe analises is gebruik om die belastinggevolge te bepaal vir individue in verskillende inkomstegroepe. Gebaseer op die bevindinge in die studie kan daar geredelik die gevolgtrekking gemaak word dat al die lande nadelige belastinggevolge instel wanneer die aftreebydrae ‘n sekere limiet, soos vasgestel deur die onderskeie lande, oorskry. Die instelling van ‘n beperking op hul bydraes beteken dat Suid-Afrikaanse belastingbetalers onderwerp sal word aan soortgelyke limiete as in die geselekteerde ontwikkelde lande. Dus is die Suid-Afrikaanse belastingwetgewing nou meer in lyn met dié van bogenoemde ontwikkelde lande.

SLEUTELWOORDE: Ontwikkelde lande, ontwikkelende lande, pensioenfondsbydraes,

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ACKNOWLEDGEMENTS

This study would not have been possible without the technical assistance and guidance provided by my study leader, Professor Karina Coetzee. Also thanks to my colleagues, family and friends for the sincere interest and motivation the past two years.

Without my mother, who is my pillar, I would not have been where I am today. Thank you for all the motivation, encouragement and patience.

A big thank you to Gary who had to listen to me every time I hit a brick wall and he was always ready to assist, helpful, kind and also supportive.

Last, but not least, I am thankful to God for all the opportunities that I am granted and for the talents that he has provided me with to be able to complete this study.

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Contents

CHAPTER 1 - INTRODUCTION...1

1.1 Introduction ...1

1.2 Literature review of the topic/research area. ...2

1.3 Motivation of topic actuality ...4

1.4 Problem statement ...5 1.5 Objectives...5 1.5.1 Main Objective. ...5 1.5.2 Secondary Objectives. ...5 1.6 Research design/method...6 1.6.1 Ontological assumptions...6 1.6.2 Epistemological assumptions. ...6 1.6.3 Methodological assumptions. ...7

1.6.4 Literature review performed during the research phase ...7

1.7 Overview of chapters ...8

CHAPTER 2 – CURRENT SOUTH AFRICAN TAX CONSEQUENCES ...10

2.2 Currently implemented section 11(k) and section 11(n) of the Income Tax Act No 58 of 1962...10

2.2.1 Definitions ...10

2.2.1.1 Pension fund ...10

2.2.1.2 Retirement annuity fund ...11

2.2.1.3 Provident fund ...11

2.2.2 Current Tax Legislation...12

2.3 Reason for changes to the current legislation...13

2.4 Amended section 11(k) of the Income Tax Act No 58 of 1962...14

2.5 Understanding the cap amount...16

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2.5.2 Impact of the cap amount ...17

2.6 Conclusion...18

CHAPTER 3 – THE CAPPING OF RETIREMENT CONTRIBUTIONS IN DEVELOPED COUNTRIES ...20

3.2 Reason for comparing South Africa to developed countries...20

3.3 Defining developed and developing countries ...20

3.3.1 Developed countries ...21

3.3.2 Developing countries ...21

3.4 Melbourne Mercer Global Pension Index ...22

3.4.1 Objective of the MMGPI...22

3.4.2. Adequacy sub-index ...24

3.4.3 Relevance of the MMGPI...26

3.5 Countries selected for comparison ...27

3.5.1 Australia...27

3.5.1.1 Tax Authority...27

3.5.1.2. Types of funds included in tax legislation ...28

3.5.1.3. Capping of contributions for tax purposes...28

3.5.1.4. Tax on benefits...30

3.5.1.5. Summary...33

3.5.2. Ireland ...34

3.5.2.1 Tax Authority...34

3.5.2.5. Summary...36

3.5.3 Denmark ...37

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3.5.3.5. Summary...41

3.6 Conclusion...41

CHAPTER 4 – COMPARISON AND CONCLUSION...43

4.2 Limitations of the study...43

4.3 Comparison and summary of differences between South Africa and developed countries ...44

4.3.1 South Africa...46

4.3.2 Australia...47

4.3.3 Ireland ...50

4.3.4 Denmark ...52

4.4 Conclusion based on the comparison ...57

4.5 Other research possibilities from the study ...60

4.6 Conclusion and summary ...60

APPENDIX A: CALCULATION OF RELEVANT TAX DEDUCTIONS...62

LIST OF REFERENCES ...67

List of tables Table 1: Current income tax implications of retirement savings ...12

Table 2: Amended section 11(k) implications ...15

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List of tables (continued)

Table 4: Overall index per country: 2014 ...26

Table 5: Income tax implications of benefits when member is younger than preservation age ...32

Table 6: Income tax implications of benefits when member is 60 years or older ...32

Table 7: Income tax rates for 2015 -2016 ...33

Table 8: Australian caps, tax payable and actions ...33

Table 9: Age-related percentage limits ...35

Table 10: Cap of deductibility of contributions for income tax purposes ...37

Table 11: Danish tax consequences ...41

Table 12: Comparison between South Africa and developed countries ...56

TITLE: The capping of the deductibility of retirement contributions for tax: A comparison

between South Africa and developed countries

KEYWORDS: Developed countries, undeveloped countries, pension fund contributions,

provident fund contributions, retirement annuity fund contributions, retirement savings, capped amount.

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CHAPTER 1 - INTRODUCTION

1.1 Introduction

In recent years, National Treasury has proposed many changes and restructuring of retirement savings to promote savings by South Africans. This includes the abolition of retirement fund tax and changes to the deductibility of contributions to retirement funds as from 1 March 2007 (SARS, 2007:9). In 2012 National Treasury once again considered reforming the tax treatment of contributions made to pension, provident and retirement annuity funds (collectively referred to as “retirement funds” hereafter) to a uniform retirement contribution model (National Treasury, 2012:3). These changes were proposed to promote household savings.

In the Tax Law Amendment Act of 2013 the deductions for retirement funds were amended in section 11(k) of the Income Tax Act No 58 of 1962 (hereafter referred to as “The Act”). These amendments would have become effective on 1 March 2015, on all contributions made on or after this date. National Treasury announced on 16 October 2014, through a media statement, that the implementation will be postponed to 1 March 2016, and possibly even 1 March 2017, due to ongoing consultation with NEDLAC (National Economic Development and Labour Council) (KPMG: 2014).

The savings behaviour of South Africans is also topical. As indicated in a study performed by Prinsloo, the gross savings of households as a percentage of the gross domestic product was 9.1 per cent for the period between 1960 and 1972 (Prinsloo, 2000:13). This decreased to 4.2 percent for the period between 1990 and 1999. As per the South African Savings Institute (SASI, 2006) this rate was just more than 1.5 percent in the first quarter of 2006. In 2014 the Ministry of Finance reported that the savings rate in 2013 was -2.2 percent (South Africa, 2013:2). It is therefore clear that the savings rate, as a percentage of the gross domestic product, is decreasing. The household savings include the contributions made to retirement funds and therefore an understanding of the household savings is relevant as all changes made to the tax legislation relating to retirement savings will be to stimulate household savings (National Treasury, 2014:1).

This study looks at the comparison between the income tax implications of retirement savings by an individual in a developing country (South Africa) and a developed country and specifically looks at the capping of retirement savings for tax purposes. Tanzi and Zee (2000:300) state that high tax levels cannot be reached in developing countries and therefore the differences between

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developed countries and developing countries will also have to be considered. The study is thus to compare the income tax implications of retirement savings in South Africa to that of developed countries. The study specifically looks at the capped amount introduced when the changes were made to section 11(k) where there previously was no fixed capped amount for the deduction of contributions made to funds. This cap states that the maximum amount of contributions (to retirement funds) that a South African taxpayer may deduct for income tax purposes is capped at an amount of R350 000 (in total per annum).

The reason for comparing the income tax implications of South Africa with developed countries is that South Africa has a dual economy (Biepke, 2007:4). This means that the South African economy shows characteristics of both developed countries as well as developing countries. The study determines how the income tax implications for retirement savings in South Africa compare to that of developed countries (as the country has a dual economy), thus determining whether the income tax implications for retirement savings are in line with those of developed countries. The cap will have an influence on the developed portion of the South African population as it will only influence highly paid individuals in the marginal tax bracket. The income tax implications for the employers are not included in the study as these will not influence the cap amount. Performing a comparison between the cap amount in South Africa to those of developed countries is therefore viable.

1.2 Literature review of the topic/research area.

Many studies have been performed on the savings behaviour of corporates as well as households in South Africa. National Treasury of the Republic of South Africa has also published research papers (titled “2014 Budget update on retirement reforms” (2014), “Presentation on Changes in SA Retirement Funds, 11 July 2013” (2013), “Retirement reform proposals for further consultation” (2013), “Enabling a better income in retirement” (2012), “Preservation portability and governance” (2012), “Improving tax incentives for retirement savings” (2012) and “Strengthening retirement savings: An overview of proposals announced in the 2012 Budget” (2012)) and media releases (such as the media releases titled “Statement on the Impact of the Proposed Retirement Reforms” (2014), “Further details on the 2014 Budget announcements on retirement reforms and non-retirement tax-free savings products” (2014), “Changes in South African Retirement Funds” (2013) and “Retirement savings discussion paper” (2012)) on the savings behaviour as well as the retirement fund reform which is taking place due to the amendments made to section 11(k) of the Income Tax Act. This published research refers to the

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savings behaviour of South Africans, the current tax implications regarding retirement savings, why changes to the Income Tax Act are necessary as well as papers on the changes to the Income Tax Act announced in the 2012 budget speech and the implications thereof to individuals. The current income tax implications in terms of the Income Tax Act No 58 of 1962 are the following:

- Employer contributions to pension and provident funds are not fringe benefits while contributions made to a retirement annuity fund will be a fringe benefit1;

- For the contributions made by the employer on behalf of the employee, an amount equal to 20% of the total employee remuneration will be deductible for the employer, in terms of SARS practice. In terms of section 11(l) of the Income Tax Act the deduction is available at the discretion of SARS and the Commissioner must allow a deduction of at least 10% of employee remuneration ;

- Employee contributions made to provident funds are not tax deductible while up to 7,5% of the retirement funding income will be deductible in terms of employee contributions made to a pension fund;

- Up to 15% of the non-retirement funding income will be deductible in terms of contributions made to a retirement annuity fund; and

- 100% of provident fund income may be paid out while at least two thirds of a pension fund or retirement annuity fund must be taken as an annuity.

The Taxation Laws Amendment Act of 2013 (South Africa, 2013a), as validated by Foster (2014:7), states that the new tax implications in terms of section 11(k) will be the following:

- The limitations will now be calculated based on the “remuneration” and not the “retirement funding income” as before;

- A maximum of 27.5% of the greater of the remuneration and the taxable income will be deductible per annum. The percentage will be multiplied by the aggregate of contributions made by the individual and the employer. This will also include provident fund contributions and employer contributions to approved life insurance; and

1_{In terms of paragraph 13 of the Seventh Schedule to the Income Tax Act the taxable fringe} benefit will be the cash equivalent of the cash value of the release of an amount owing by the employee. The employer’s contribution to a pension fund or provident fund is due based on the fund rules and is therefore not an amount due by the employee. As such, this will not be a fringe benefit in terms of this paragraph.

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- There will be a cap of R350 000 per year on the amount deductible as discussed above; and

- All employer paid contributions made to a pension -, provident - or retirement annuity fund will now be taxed as a fringe benefit in terms of paragraph 2(l) of the Seventh Schedule to the Income Tax Act; and

- For pension -, provident- and retirement annuity funds two thirds of the benefit must be taken as an annuity while one third may be paid out as a lump sum.

1.3 Motivation of topic actuality

No information could be found on comparisons of the tax implications of retirement savings between different countries except for comparisons between OECD countries (Yoo and De Serres, 2005). South Africa is only an observer to the OECD and has therefore not been included in these studies. Since the capped amount is fairly new, no comparison could be found where the cap of contributions was compared between countries and South Africa was included in those studies. The impact of the cap is only researched by Australia as indicated above. This clearly indicates that there is a gap and therefore this research attempts to fill this gap.

Since changes are regularly made to the taxation of retirement savings, this research area is relevant. A whole pension fund reform process is also currently in process as announced by The Minister of Finance (South Africa, 2014:4). Amendments were made to section 11(k) of the Income Tax Act No 58 of 1962 where the cap amount of R350 000 per year was introduced. These changes should have been implemented from 1 March 2015. National Treasury announced on 16 October 2014, through a media statement, that the implementation will be postponed to 1 March 2016, and possibly even 1 March 2017, due to ongoing consultation with NEDLAC (National Economic Development and Labour Council) (KPMG: 2014). The topic is therefore relevant as the changes made to the section are fairly new. The changes were made to stimulate household retirement savings due to the fact that South Africa’s savings rate is very low, as indicated in a press release by National Treasury (South Africa, 2012:1). In this press release it is stated that households can retire comfortably and they can reduce excessive reliance on debt when the household savings are increased. This is also corroborated in 1.1 above where statistics regarding household savings were obtained. Based on the fact that much is written on the topic as included under “Literature review” above, it portrays the actuality of the topic.

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Based on the above it would be relevant to determine whether the changes made to the Income Tax Act will be in line with that of developed countries, specifically referring to the fact that the amount of contribution deductions is capped for income tax purposes.

1.4 Problem statement

The household retirement savings of South Africans are declining. Changes to the income tax implications to stimulate savings when contributions are made to retirement funds are regularly discussed, as indicated in 1.1 above. For this study it is important to look at how the income tax implications for these contributions differ between developed countries and South Africa. This study specifically looks at whether the amounts of contributions are capped in developed countries and how this compares to the South African cap.

The following problem statement is addressed in this dissertation:A comparison on how the income tax implications for retirement savings differ between developed countries and South Africa relating to the cap of retirement saving deductions.

1.5 Objectives

1.5.1 Main Objective.

The main objective of the study is to determine how the income tax implications of retirement savings regarding the capping of contributions compare between developed countries and South Africa.

Developed countries are selected and these countries’ legislation relating to retirement savings are then compared to South Africa’s legislation on the same matter. The objective is to determine which changes need to be made to the Act to be more in line with the income tax implications of retirement savings in a developed country.

1.5.2 Secondary Objectives.

The secondary objectives of the dissertation are the following:

- To determine what the income tax implications for retirement savings in South Africa will be in terms of the new provisions of the Taxation Laws Amendment Bill, 2013 (chapter 2);

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- To gain an understanding of the Mercer Melbourne Pension Fund Index as the developed countries from this index are used in the study (chapter 3);

- To determine the income tax implications for retirement savings in developed countries relating to the capping of contributions made (chapter 3);

- To determine the differences between the income tax implications for retirement savings in South Africa and developed countries (chapter 4); and

- To recommend changes that can be made to South African tax legislation regarding retirement savings (specifically referring to the capped amount) to be more in line with developed countries as analysed in this chapter and to summarise and conclude (chapter 4).

1.6 Research design/method

Paradigmatic assumptions and perspectives

1.6.1 Ontological assumptions.

Ontology is how the researcher views the world (McKerchar, 2008:1). Ahmed (2008:2) states that ontology is “the study of being”. The question to answer when looking at the ontological assumption would be to discuss what the nature of reality is.

In this study a realist view is adopted. The reality is external and it exists independently. The information for the countries and the tax consequences of retirement savings can be gained independently. This can be performed by research on the income tax implications of retirement savings in South Africa as well as in developed countries by gaining knowledge of the relevant income tax regulations.

1.6.2 Epistemological assumptions.

The epistemological assumptions look at the theory of knowledge. This describes the relationship between the knower and what can be known.

An interpretivist paradigm is followed in the study as knowledge can be derived from evidence gathered through the research phase. A conclusion could be made on what changes should be made to South African tax law regarding the cap on retirement savings to be more in line with that of developed countries after the tax law of South Africa as well as developed countries have been researched. Research will be qualitative in nature. Inductive reasoning is followed as deductions are made after the different tax laws have been researched.

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1.6.3 Methodological assumptions.

The methodological assumption looks at how the enquirer can perform research to determine whether what he/she believes to be correct, is correct. Qualitative methods are followed as the relationship between data is considered. Legal research is also performed as tax laws are researched. This is a doctrinal approach as research in law is performed as the technical aspects of tax law are considered in the study.

Descriptive research is performed. This is the chosen methodology as the main objective of this methodology is to describe the state of affairs as it is in the present. This method allows the researcher to report on what is currently happening. Descriptive research is performed as the objective of the study is to compare the income tax implications of retirement savings in a developing country (South Africa) to that of developed countries (for example Denmark, Australia and Ireland).

The descriptive research is in the form of applied research. The aim of applied research is to find a solution for an immediate problem. In this case all the information is available. It should just be analysed and a conclusion should be reached.

The research is qualitative as the research areas are not based on the measurement of amounts. No quantitative research was performed as no quantitative data was collected from which conclusions were made. The qualitative research includes references to quantitative information when looking at the income tax implications as these include amounts.

Since there is a comparison between the tax implications in South Africa and those of developed countries, comparative research was also performed.

1.6.4 Literature review performed during the research phase

The purpose and the objective of the literature review are to answer the research question. A literature review was performed to gain an understanding of the income tax implications of retirement savings, specifically the cap amount, in South Africa as well as in developed countries; for example Denmark, Australia and Ireland. This was necessary to be able to perform a comparison between South Africa and developed countries. A literature review was also performed to define the difference between a developed country and a developing country.

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The following sources of information were used during the research phase:  Journals;  Articles;  Legislation;  Books;  Reports;

 Websites (scholarly websites as well as databases on the North-West University library website); and

 Theses.

1.7 Overview of chapters

Chapter one gives an introduction as well as the background to the study. The research question and the objective of the study are included. The research methodology is explained as well as the motivation for the specific research methodology.

The objective of chapter two is to understand what the income tax implications of retirement savings are in South Africa. This includes an understanding of the amended section 11(k) included in the Income Tax Act No 58 of 1962. This chapter specifically looks at the cap amount that was introduced in the Taxation Laws Amendment Bill 2013. An understanding of this is important to be able to compare the South African income tax implications to those of developed countries.

As the study looks at the different tax implications for developed and developing countries, assigning definitions to the terms “developed countries” and “developing countries” are addressed in chapter three. The developing country used in this study is South Africa.

In chapter three the rationale for the selection of the developed countries is discussed. The objective of this chapter is to substantiate the use of these countries in the study. An understanding of the Melbourne Mercer Global Pension Index (regarding pension funds) is also discussed as these countries take up top positions on this index.

Further, the objective of this chapter is to understand what the income tax implications in the developed countries are when contributions are made to retirement funds, specifically focussing

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on the capping of contributions. This understanding is necessary to be able to compare the income tax implications with that of South Africa.

Chapter four compares the income tax implications of the developed countries with the income tax implications in South Africa. The objective of the chapter is to determine the similarities as well as the differences between the legislations of the developed countries and South Africa regarding retirement savings.

In this last chapter a conclusion is reached on the differences between the income tax implications of retirement savings regarding the cap in South Africa and of those in developed countries. The research problems are answered. The chapter also includes recommendations on how the Income Tax Act of South Africa can be adapted to be more in line with the income tax implications of those in developed countries. A summary is provided.

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CHAPTER 2 – CURRENT SOUTH AFRICAN TAX CONSEQUENCES

The objective of this chapter is to understand what the income tax implications of retirement savings will be in South Africa. An understanding of the current section 11(k) and section 11(n) of the Income Tax Act (No 58 of 1962) is discussed. The chapter specifically looks at the cap amount of retirement savings for income tax purposes, which was introduced in the Taxation Laws Amendment Act of 2013. An understanding of the South African income tax implications is important in order to compare these implications to those of developed countries.

2.2 Currently implemented section 11(k) and section 11(n) of the Income Tax Act No 58 of 1962

Currently the requirements for the deductibility of pension fund contributions are prescribed in section 11(k). The requirements for the deductibility of contributions made to retirement annuity funds are prescribed in section 11(n). The contributions made to a provident fund are not deductible in the hands of the employee. In terms of section 11(l) the contributions made by an employer to a pension fund, provident fund or benefit fund on behalf of its employees are deductible. This excludes a fund defined in paragraph a) of the definition of a benefit fund, which is any friendly society registered under the Friendly Societies Act. Three different deductions are currently available in the tax legislation; two of these deductions are for the taxpayer (the employee) and one for the employer (Income Tax Act No 58 of 1962).

2.2.1 Definitions

It is important to define the different types of funds to which contributions are made before the tax implications of the different funds can be discussed.

These funds are defined in section 1 of the Income Tax Act No 58 of 1962 (South Africa):

2.2.1.1 Pension fund

A “pension fund” includes any “pension, provident or dependents’ fund or any pension scheme established by law”. This also includes the above-mentioned funds established for any municipal employees or employees of any local authority. In subparagraph (c) in proviso (ii)(dd) it is also stated that not more than a third of the total value may be paid out as a single payment and the remainder must be paid out as an annuity, except where two-thirds of the total value does not

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exceed R50 000 or where the employee is deceased. In such cases, the full benefit may be paid out as a lump sum. In the Taxation Laws Amendment Bill of 2013, this amount was increased to R100 000 (section 4(1)(zE)).

In terms of section 1 of the Pension Fund Act (No. 24 of 1956) a pension fund is an “association of persons” that is established to provide annuities or lump sum payments to the members or former members of the association when they reach retirement age. The pension fund will also provide these benefits to “dependents of the members or former members” when the members die.

2.2.1.2 Retirement annuity fund

A “retirement annuity fund” means “any fund (other than a pension fund, provident fund or benefit fund) which is approved by the Commissioner”. The fund should be permanent and “bona fide established for the sole purpose of providing life annuities” or annuities to the dependents or nominees of deceased members. Not more than a third of the total benefit may be paid out as a lump sum, “except where the two-thirds of the total value does not exceed R50 000 or where the member is deceased”. In the Taxation Laws Amendment Bill of 2013, this amount was increased to R100 000 (section 4(1)(zZb)).

2.2.1.3 Provident fund

A “provident fund” includes any fund which is not a pension fund, pension preservation fund, provident preservation fund, benefit fund or retirement annuity fund which is approved by the Commissioner. The fund should be permanent and bona fide be established to provide annuities to the members or the dependents or the nominees in the case where the member is deceased. The purpose of the fund may also be to provide benefits other than annuities.

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2.2.2 Current Tax Legislation

The impact of the different sections as in the Income Tax Act are briefly summarised.

Table 1: Current income tax implications of retirement savings

Section Section 11(k) Section 11(l) Section 11(n)

Deduction available for

Employee Employer Employee

Deduction relating to

Pension fund contributions

Any sum contributed to pension, provident or benefit fund (excluding friendly societies but including medical aid funds)

Retirement annuity fund contributions

Deduction (current contributions)

The greater of:

- R1 750; or - 7.5% of the remuneration derived during the year in respect of the ‘retirement-funding employment’.2 Limited to the actual contribution made.

Deduction of 10% of the approved remuneration. Approved remuneration is the fair and

reasonable amount of remuneration that accrued to the employee in respect of the services rendered during the year of assessment.

In practice a deduction of up to 20% is allowed by SARS. (Stiglingh et al, 2014:168)

The greater of:

- 15% of the amount of income other than ‘retirement-funding employment’; or - R3 500

less any amount deducted in terms of section 11(k); or - R1 750. The deduction is limited to the income of the taxpayer. The deduction cannot create or increase an assessed loss. The amount not deducted may be carried forward.

2_{The term is defined in section 1 of the Income Tax Act. This will include remuneration in} terms of the Fourth Schedule to the Income Tax Act. This includes remuneration, emolument, salary as well as fees that form the pensionable salary – thus the amount on which the pension or provident contributions are based. This definition will not be included in the Act after the amendments.

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Table 1: Current income tax implications of retirement savings (continued)

Section Section 11(k) Section 11(l) Section 11(n)

Deduction (arrear contributions) - Excess amount can be carried forward to the next period. - The amount is also limited to the deduction that the member would have received in terms of section 11(n) in the previous year of assessment (as it applied in that year). - The excess amount can be carried forward to the next period.

Fringe Benefit Where an employer pays an amount to the pension fund on behalf of the employee, it is not a fringe benefit as it does not qualify as the payment of debt on behalf of the employee. (Par 2(h) of the Seventh Schedule – Income Tax Act No 58 of 1962)

Not applicable. Where the employer

made a contribution on behalf of the employee and it has been included in the income of the employee, it is deemed to be made by the employee for this section.

Income Tax Act No 58 of 1962 ((own compilation)

2.3 Reason for changes to the current legislation

In the Explanatory Memorandum on the Taxation Laws Amendment Bill of 2013 the reasoning behind the revised contribution incentives for retirement savings is discussed (South Africa, 2013b). It is stated that the government has been encouraging South Africans to contribute to retirement by giving them a tax incentive. The tax treatment is also fragmented and it differs between funds. A more consistent treatment is preferred where the result will be the same irrespective of the source of the funding. The current treatment of the contributions made by

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employers and individuals does not always produce an equitable result (South Africa, 2013b).

As indicated in a press release by National Treasury (South Africa, 2014), the proposed retirement reforms are aimed at ensuring that pension fund members are better protected and that they will have enough savings to retire comfortably. The government wants to encourage workers to keep their savings until they retire. It is also stated that only six percent of South Africans will be able to maintain their lifestyle and be able to replace their income when they retire (South Africa, 2014).

The press release also indicates that workers cash in their retirement savings when they resign instead of preserving these funds. The consequence of this is that the savings do not have enough time to grow and individuals end up not having sufficient savings for retirement.

In current legislation, the members of a provident fund can get their full benefit as a lump sum. This leaves people that retire vulnerable and in later years they cannot afford their retirement (South Africa, 2014). The Government therefore wants to encourage retirees to reduce the lump sums that they take from their provident fund when retiring and encourages them to take the biggest part of the benefit as an annuity. The accumulated funds up until the effective date of the new legislation can still be taken as a lump sum (South Africa, 2014). For members over 55 the funds can still be taken as a lump sum. The conversion will thus only be for new contributions made by members younger than 55 years of age.

2.4 Amended section 11(k) of the Income Tax Act No 58 of 1962

As indicated above, National Treasury proposed changes to the current legislation to encourage workers to save more. The changes were included in the Taxation Laws Amendment Bill of 2013 (South Africa, 2013). These amendments would have become effective on 1 March 2015 on all contributions made on or after this date. A recent proposal was made by National Treasury to Parliament to postpone this implementation until March 2017. The amended section 11(k) would have the following to effect as indicated in the Taxation Laws Amendment Bill of 2013 (South Africa, 2013):

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Table 2: Amended section 11(k) implications

Section Section 11(k)

(South Africa, 2013)

Deduction available for Employees

Deduction of contributions Any amount contributed to any pension fund, provident fund or retirement annuity fund.

Deduction Total deduction per year may not exceed the lesser of:

- R350 000

- 27.5% of the higher of:

 Remuneration as defined in the Fourth Schedule

 Taxable income as

determined before taking any deduction in terms of this section into account.

If contributions could not be deducted in a prior year due to the fact that it exceeds the deduction allowable, it will be deemed to be an amount contributed in the current year of assessment.

Fringe benefit Any amount contributed to a fund on behalf of an employee will be a fringe benefit and will be deemed to be a contribution made by the employee for purposes of section 11(k) (Par 2(l) of the Seventh Schedule to the Income Tax Act No 58 of 1962).

Taxation Laws Amendment Bill 2013 (own compilation)

In terms of the amended section 11(l), the employer will be able to deduct any contributions made on behalf of the employee to any pension fund, provident fund and retirement annuity fund and it will not be capped to 10% (20% in practice) (Stiglingh et al, 2014:168) of the approved remuneration as the current legislation reads. When contributions are made to a defined contribution fund the fringe benefit will be the actual cash contribution. In the case of a defined benefit fund a special formula will be used to determine the fringe benefit (South Africa, 2013). Section 11(n) will also be deleted as section 11(k) now provides for contributions made to pension funds, provident funds and retirement annuity funds and therefore section 11(n) is not necessary anymore.

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It should also be considered that the benefit that is being paid out by the pension fund, provident fund and the retirement annuity fund may be taxed in terms of the Second Schedule to the Income Tax Act. No amendment regarding the taxation of lump sum benefits has been made when the amendments were made to section 11(k).

As indicated above, a cap amount of R350 000 was introduced in the Taxation Laws Amendment Bill. This caps the amount of the deduction available for all contributions made to pension funds, provident funds and retirement annuity funds.

2.5 Understanding the cap amount

The cap amount as introduced in the new section 11(k) will be the main focus in the comparison following in the next chapter. The cap was introduced to support the fiscus and to ensure that high earners do not shield their income from the tax collector (Nathan, 2012). The cap will have

an influence on taxpayers where the taxable income exceeds

R1 272 730 (R350 000 ÷ 27.5%) per annum (Foster, 2014). Ndlovu (2013) states that the Minister should increase the cap amount to be more in line with other countries to encourage savings.

2.5.1 Disadvantages of the cap

Nathan (2012) states the following disadvantages of the cap:

 It disincentivises savings in countries with low savings rates;  it may lead to offshore savings; and

 by disallowing higher contributions now, Treasury forfeits higher tax revenues in future (when the benefit is paid out).

He also states that if the cap is not adjusted annually, it may also start to limit middle income households. The impact of the cap may be that members of retirement funds cannot deduct all their contributions and therefore they may consider investing offshore as there is no tax incentive to contribute to South African funds. Benefits paid by retirement funds are taxed when a payment is made to a member in terms of the Second Schedule to the Income Tax Act No 58 of 1962. If the contributions made by members are capped when contributing, this means that the pension fund benefit will be smaller and therefore Treasury will lose tax when the benefit is being paid out. This will not be the case as there will be tax on a benefit when contributions are made and when a contribution is not deductible the taxable income of the person will be more and therefore

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SARS will not lose any tax. In the Explanatory Memorandum to the Taxation Laws Amendment Bill 2013 (South Africa, 2013:9) it is stated that the cap is introduced to ensure that wealthy individuals do not get excessive deductions for contributions made to funds.

2.5.2 Impact of the cap amount

The capping of the amount will work as follows (example taken from Momentum, 2014:2) for example:

The cost to company (remuneration) of a person is R1 750 000 per annum. The basic salary is R1 500 000 per annum. His employer contributes 15% (of his basic salary) to the defined contribution pension fund while he contributes 7.5% of his basic salary. He will also contribute 5% towards a retirement annuity fund. The contributions will thus be the following:

 Employer contribution to pension fund: R225 000

 Member contribution to pension fund: R112 500

 Member contribution to retirement annuity fund: R75 000

He also receives R120 000 from his business and incurs business expenses of R250 000. His taxable income will be determined as follows:

Basic salary R1 500 000

Employer contribution (fringe benefit) R225 000

Business income R120 000

Business expenses (R250 000)

Taxable income R1 595 000

As his remuneration of R1 750 000 is higher than the taxable income as determined, the contribution deductible will be calculated based on the remuneration,

The total contributions made equals R412 500. The deduction will be calculated as the lesser of:

- 27.5% of the higher of the taxable income or the remuneration; and

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Therefore:

- 27.5% of R1 750 000 is R481 250.

As this is more than R350 000, only R350 000 will be deductible in the current year of assessment and the balance will be deductible in the following year of assessment. If his contributions stay the same year on year, the amount will keep rolling forward. If it cannot be deducted, it will be taken into account when the lump sum is paid on retirement and the amount can then be deducted from the lump sum before the tax implications of the lump sum are determined.

It is clear from the above that the new section will cap the amount of deductible contributions at R350 000.

The current income tax implication would be that there will be a deduction for the pension fund contribution as well as the retirement annuity fund contribution. The retirement annuity fund contribution to be deducted will be limited to the greatest of 15% of the income other than “retirement-funding employment”, R3 500 minus any pension fund contributions deducted for income tax purposes or R1 750. The income other than the retirement-funding employment will thus be the R120 000, which is income received from the business, minus the business expenses to the amount of R250 000. The deduction that the taxpayer would receive would thus be R131 250 (R1 750 000 x 7.5%). The deduction for the retirement annuity contributions will be R1 750 as the amount of pension contributions deducted will be more than R3 500 and the income other than the “retirement-funding employment” is negative. This means that he taxpayer will get a deduction amounting to R133 000.

In terms of the old legislation the taxpayer would therefore receive a deduction of R133 000, while he will receive a deduction of R350 000 under the new tax legislation, thus indicating that the taxpayer will be in a better tax position in terms of the new legislation.

2.6 Conclusion

In this chapter the current income tax implications as well as the amended section 11(k) have been discussed. The reasons for the amendments have also been discussed. The chapter refers specifically to the cap imposed on the deductions of retirement savings for income tax purposes. An understanding of the South African income tax implications has therefore been discussed, as the next chapter looks at the income tax implications in other developed countries and

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specifically at whether they cap the amount of contributions that is deductible for income tax purposes.

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CHAPTER 3 – THE CAPPING OF RETIREMENT CONTRIBUTIONS IN DEVELOPED COUNTRIES

In chapter 2 the South African tax consequences of retirement contributions were discussed. This chapter defines developed and developing countries. As the developed countries used in the study are selected from the Melbourne Mercer Global Pension Index, an understanding of this index will also be gained. The rationale for the selection of the countries is explained, after which the income tax implications and the cap of retirement contributions for taxation purposes are discussed for the selected countries. The tax implications of the developed countries, and specifically whether there is a cap on the amount of retirement contributions that can be deducted for income tax purposes, are then compared to the income tax implications in South Africa as discussed in the previous chapter.

3.2 Reason for comparing South Africa to developed countries

The cap will have an influence on taxpayers whose taxable income exceeds R1 272 730 per annum (Foster, 2014). This means that the cap amount will only have an influence on taxpayers who fall within the highest marginal tax bracket as included in the Income Tax Act. These taxpayers represent the developed sector of our country. As this is the case, South Africa will be compared to developed countries. The reason is thus to determine how the South African tax law should be changed to be more in line with those of developed countries, and also to see where South Africa can learn from other developed countries.

3.3 Defining developed and developing countries

In the comparison which will be performed, South Africa will be the developing country in the study, while countries from the Melbourne Mercer Global Pension Index will be used as developed countries. It is therefore important to define developed and developing countries before the comparison is performed.

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3.3.1 Developed countries

The Oxford Dictionary defines developed as being “of a country or region advanced economically and socially” (Oxford, 2015). A developed country is a country that shows a modern infrastructure (both physical and institutional) (Parker & Veldsman, 2010:1). These countries move away from low-value-added sectors like agriculture and resource extraction. The focus of these countries is more intellectual and they are involved in capital based economic activities. The standard of living is high and countries have economic systems based on continuous, self-sustaining economic growth. According to Investopedia there is a relatively high level of economic growth and security. The evaluation of the degree of development of a country can be determined by means of the following criteria: the gross domestic product (GDP) or the income per capita, the level of industrialization, general standards of living and the amount of widespread infrastructure. Other non-economic factors are also included in evaluating the development of a country. This will include the degree of education, literacy and health (Investopedia, s.a.).

3.3.2 Developing countries

Developing countries have relatively low standards of living, undeveloped industrial bases and moderate to low human development indices (HDI). These countries have low per capita income, widespread poverty and low capital information. A significant degree of industrialisation relative to the populations has not been achieved. There is also a strong correlation between low income and high population growth (Parker & Veldsman, 2010:1). Investopedia indicates that the term “developing countries” refers to countries that do not have the same level of economic security, industrialization and growth as developed countries. The United Nations Conference on Trade and Development (UNCTAD) states that developing countries are highly disadvantaged in the development process, many of them based in their geographical place. There is also a higher risk for developing countries that they will not be able to come out of poverty when the country is poverty-stricken. According to The International Statistical Institute, South Africa is ranked on the list of developing countries (The International Statistical Institute). This is based on the fact that the Gross National Income (GNI) is less than US$11 905 per capita per year.

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3.4 Melbourne Mercer Global Pension Index

The Melbourne Mercer Global Pension Index (MMGPI) was introduced in 2009 (Melbourne Mercer Global Pension Index). The Index is a partnership between the Australian Centre for Financial Studies (ACFS) and Mercer. Mercer is a global leader in pension fund management and consulting while ACFS is an independent non-profit research institute. The funding is provided by the Victorian Government (Melbourne Mercer Global Pension Index).

The Index includes a wide range of countries; ranging from developed to developing countries. Since 2009 the Index has been providing a report regarding pension funds on a yearly basis. The number of countries used in the study increased to 25 in 2014 while 11 countries were used in the study in 2009. The pension systems around the world are under pressure due to longer life expectancies, increased government debt in many countries, uncertain economic conditions and the global shift to defined contribution plans. South Africa has been included in the Index for the first time in 2014 (Melbourne Mercer Global Pension Index).

3.4.1 Objective of the MMGPI

The objective of the MMGPI is to use more than 50 questions to benchmark each country’s retirement income system. The Index will also indicate any shortcomings and from these the Index may also suggest possible areas of reform (Melbourne Mercer Global Pension Index, 2014: 3). An index is calculated per country out of 100. The Index takes into account the adequacy, sustainability and the integrity of pension fund systems. The Index value per country will represent a weighted average of three sub-indices. The adequacy is weighted at 40%, sustainability at 35% and integrity at 25% (Melbourne Mercer Global Pension Index, 2014:6). The same weighting system has been used since the 2009 report.

The adequacy looks at the benefits that are currently being provided and also looks at the benefit design features. Sustainability looks at whether the system will be able to provide the same benefits in future. The confidence that the citizens have in the pension fund system will impact the integrity sub-index. The 25 countries are then ranked based on the index calculated (Melbourne Mercer Global Pension Index, 2014:6).

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Table 3: MMGPI sub-indices and the indicators Sub-index Indicators Adequacy _{ Benefits}  Savings  Tax support  Benefit design  Growth of assets Sustainability _{ Coverage}  Total assets  Contributions  Demography  Government debt Integrity _{ Regulation}  Governance  Protection  Communication  Costs

(Melbourne Mercer Global Pension Index, 2014: 6) (own compilation)

The Index focuses on the provision of financial security in retirement. It is not a comprehensive measurement of living standards when people have retired (Melbourne Mercer Global Pension Index, 2014:15). The Index has also started focusing on transparency and trust in pensions (Melbourne Mercer Global Pension Index, 2014:3). With the recent reform from defined benefit to confined contribution systems, it is essential that members have greater clarity and understanding so that they can make better decisions. Members are starting to make more decisions regarding the contribution levels, investment selection as well as the form of their retirement benefit (Melbourne Mercer Global Pension Index, 2014:19). In a defined benefit plan, the employee bears the risk of the investment return being higher or lower than expected. In a defined contribution plan this risk is transferred to the members of the fund (South Africa, 2004:6). The change from defined benefit to defined contribution funds was made as the defined benefit fund is designed so that the employee will be in the service of the employer for a long time. When a benefit is paid out before resignation, but when the member retires or dies, the benefit will be less than it would have been if the member invested the money himself (South Africa, 2004:10).

As indicated above, the Index also looks at the tax support that is provided by the pension system as part of the adequacy sub-index. As such, the tax also influences how the countries are ranked and this substantiates why the countries selected are from the MMGPI. Even though the ranking

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of the countries is not entirely based on their taxation systems, this will have an influence on the rankings. The adequacy sub-index will now be discussed further.

3.4.2. Adequacy sub-index

As per the 2014 report (Melbourne Mercer Global Pension Index, 2014:13) the adequacy sub-index is the most obvious way to compare different pension systems as the primary objective of any pension system is to provide adequate retirement income. The following six factors are taken into consideration when determining the adequacy (Melbourne Mercer Global Pension Index, 2014:13):

 Are voluntary contributions made by the member of the fund treated more favourably by the tax system than having the money in the bank? Will the pension fund be taxed on the investment income received? If the investment income is taxed this means that the compounding effect of interest will be lost and the adequacy of future benefits will therefore be reduced.

 Is the retirement age determined or can the retirement income leak before the member retires?

 If a member retires, will he receive his full benefit? Will the member be able to move the pension benefit to another fund? This therefore determines what happens when a person changes employment.

 Which part of the retirement benefit should be taken up as an income stream? Are there any tax incentives for taking the benefit as an income stream rather than a lump sum?  When there is divorce or separation, are the individual’s pension benefits taken into

account in the division of the assets? This may have a major influence on the financial security of one or both of the partners.

 Should contributions be paid to the pension fund in the period that a person is temporarily out of the workforce and receives income support? The individual’s retirement income can be affected if there is no requirement that the benefits should continue to accrue (Melbourne Mercer Global Pension Index, 2014:13).

This sub-index takes into account the tax treatment in terms of retirement funds and therefore the countries selected for the comparison are the developed countries with the highest rankings in terms of the adequacy sub-index. The sub-index considers whether there are any tax incentives to take the pension benefit as an income stream and not a lump sum benefit. It also considers whether the tax treatment of voluntary contribution to a pension fund is better than investing money in a bank account.

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The higher the index in a certain category, the better the country performs in that specific category. Assigning marks when certain criteria are met and determining an index out of 100 per country, a comparison can be made between the countries on the MMGPI and the countries with better pension fund systems in accordance with the index can be identified.

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The following represents the overall index per country as disclosed in the 2014 report:

Table 4: Overall index per country: 2014

Source: (Melbourne Mercer Global Pension Index, 2014: 8)

As can be seen in the table above, the three sub-index values are used to determine an overall index value per country. It can be seen that Australia has the highest overall index value with an overall score of 79.9, indicating that Australia has the best pension system of all the countries included in the MMGPI. South Africa is much lower on the list with an overall index of 54.

3.4.3 Relevance of the MMGPI

The MMGPI is used to select the developed countries in the comparison between South Africa and developed countries. The reason for this is that the Index indicates the countries with the

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best pension systems in the world. As the tax system is presented as part of the adequacy sub-index, the countries with the highest rankings in this sub-index were used in the comparison. Comparing South Africa to developed countries from the Index, ensures that the South African pension system is compared to the best pension systems world-wide. As all countries would strive to good pension systems, it will be appropriate to select countries from this Index.

3.5 Countries selected for comparison

The countries selected for the study is from the MMGPI. The countries selected are the top developed countries as per the adequacy sub-index for 2014. The 2014 report is used as this represents the most recent report. Comparing South Africa to the top developed countries on the list will give a clear indication of the differences between the South African income tax implications and the income tax implications of developed countries. The countries selected for the comparison are the following: Australia (81.2%), Ireland (77.6%) and Denmark (77.5%). The tax consequences for the 2015 year of assessment have been used in the study as it is the most recent information available. For all countries the 2015 year of assessment has been used to make the information more comparable. The tax consequences regarding retirement savings will now be discussed, including whether the contributions deductible for tax purposes will be capped.

3.5.1 Australia

3.5.1.1 Tax Authority

Australia has the highest value as per the adequacy sub-index per the MMGPI, being 81.2 (Melbourne Mercer Global Pension Index, 2014:8). The Australian Taxation Office is responsible for revenue collection of the Australian government on behalf of the Commissioner of Taxation (Australian Government, 2015a). As with the tax legislation in all countries, the legislation makes provision for different types of funds. This will now be discussed.

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3.5.1.2. Types of funds included in tax legislation

In Australia there are five basic types of funds:

 Industry funds: These funds are available to all members of the public. It may also be the case that the employee works for a specific industry and the employer signs the employee up with the fund.

 Retail funds: These funds are run by financial institutions and are available to the public.  Public sector funds: These funds offer defined benefit plans and constitutionally protected funds to the members. These funds are open for the Commonwealth, state and government employees.

 Corporate funds: These are funds that are available for the people working for a specific institution or employer. These funds may be defined benefit funds.

 Self-managed super funds: These funds work like all the other super funds but all investment decisions and legal responsibilities lie with the trustee, which will be the member of the fund. The member is also responsible to manage the fund which means that the member makes the investment decisions (Australian Government, 2015d).

3.5.1.3. Capping of contributions for tax purposes

In Australia the pension funds are referred to as “superannuation” (in short referred to as “super”). The tax that you pay on your super will depend on the following:

 Whether the contribution was made before or after income tax was paid on the amount;  Whether the super contributions cap has been exceeded; and

 Whether the taxpayer is a high-income earner (Australian Government, 2015b).

In Australia it has to be considered whether the contributions made are concessional or non-concessional (see below). There will be different tax implications and therefore these contributions have to be considered separately. There may also be excess contributions tax or Division 293 tax as discussed below (Australian Government, 2015b). A deduction of the contributions will be available unless more than 10% of your assessable income is obtained from an employer (Australian Government, 2014). The assessable income is the income that tax will be payable on and therefore includes all income received from the employer. For an employee there will thus not normally be a deduction for the contributions made to a retirement fund.

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Before-tax super contributions (Concessional)

Before-tax contributions are from amounts that have not been taxed yet. The before-tax super contributions will include the following (Australian Government, 2015b):

 Contributions made to super funds by the employer. This may be compulsory payments made by the employer or salary sacrifice payments made to the super funds;

 Where contributions will be deductible from income as in the case where the contributions are made by someone who is self-employed; and

 Notional taxed contributions made by a member of a defined benefit plan.

These contributions are taxed at a rate of 15% in the fund. These contributions (being concessional contributions) are not taxed yet and they will not be included in the income to be taxed as the contributions made are taxed separately at the rate of 15%. There is, however, a cap on the amount of contributions that should not be taxed at the marginal tax rate but at a rate of 15%. For the concessional contributions the yearly cap for the 2015 – 2016 tax year for taxpayers under 50 years old will be $30 000 for the year. When the taxpayer contributes more than this limit, the amount over $30 000 will be added to the taxpayer’s income and be taxed at the marginal income tax rate. When the taxpayer is 50 or over 50, the cap will be $35 000 (Australian Government, 2015c).

After-tax super contributions (Non-concessional)

After-tax super contributions will be made from amounts that have been taxed already. The after-tax super contributions can include the following:

 Contributions made by an employee or an employer from after-tax income;  If your spouse makes contributions to your super fund;

 Where personal contributions are made to super funds that cannot be deducted from income tax (Australian Government, 2015b).

These contributions are not subject to tax. There is, however, a cap of $180 000 for the 2015-2016 tax year of the amount of non-concessional contributions that can be made. The contributions over the $180 000 will be taxed at a rate of 49%. There is also a bring forward provision for people under 65. These taxpayers are allowed to go over the non-concessional cap by up to two years’ worth of contributions without any penalty. This means that $540 000 can be contributed in a year (Australian Government, 2015c).

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Excess contributions tax

Depending on your age, there is a limit on the before-tax and the after-tax contributions that can be made to your super. In the case of before-tax super contributions, if the cap is exceeded the excess will be included in the income tax return and taxed at the marginal rate. Some of the excess contributions can then be withdrawn to pay the additional tax (Australian Government, 2015b).

In the case where the after-tax super contributions cap is reached, the taxpayer can decide to withdraw the excess contributions and also any earnings on these contributions. The earnings will be included in the income tax return of the taxpayer and taxed at the marginal rate. If the excess cash is not withdrawn, tax will be payable on the excess (Australian Government, 2015b). The excess contributions tax is discussed under the “Before tax contributions” and the “After-tax contributions” above as the excess contributions “After-tax will differ based on the type of contribution made.

Division 293 tax for very high income earners

When a taxpayer’s income, combined with contributions to super, exceeds $300 000 per year, additional tax, known as Division 293 tax, will be payable. Division 293 tax will be calculated as 15% of the taxable concessional (before-tax) contributions above the $300 000 threshold (Australian Government, 2015e). This will amount to R2 625 000 ($300 000 x R8.75) as at 27 February 2015. If the taxpayer is a member of a defined benefit fund, the tax may be calculated on the notional contributions which are not taxed. This means that the amount is based on the annual increase in a defined benefit superannuation account based on what the individual expects when he/she leaves the fund (Australian Government, 2015e).

3.5.1.4. Tax on benefits

The objective of this study is to compare the cap of contributions in South Africa to those of developed countries. The contributions cannot be seen in isolation as it may be that the contributions are not capped, as there will be adverse tax consequences when benefits are paid out. Therefore the tax on benefits will be considered.

In Australia the tax consequences on benefits paid out will differ based on a number of factors, such as the age of the member and whether the benefits come from a taxed or untaxed source. The tax consequences will also differ based on whether the benefit is being paid out as a lump sum (once-off payment) or as an income stream (Australian Government, 2015f). The tax will

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depend on which part of the benefit is tax-free, taxable or untaxable. This will depend on the type of contribution that was made and whether tax was paid on the contributions (Australian Government, 2015g). Non-concessional (after-tax) contributions made will be tax-free as tax has already been paid on the amount. Other after-tax contributions will also be tax-free unless the taxpayer has received a deduction for the contributions made to a super fund. Where the member has made concessional contributions, the benefit will be taxable when paid by the super fund. The tax payable on the withdrawals will depend on the age of the member and also whether the super fund has paid tax on the contributions (Australian Government, 2015g).

Where the super fund has paid tax at a rate of 15% on the concessional contributions, these benefits will be the taxed element of the taxable super benefits. If no tax has been paid on the concessional benefits, the money is the untaxed element of the super benefit that will be taxed (Australian Government, 2015g).

Therefore a benefit will normally include a tax-free, as well as a taxable component, which will consist of a taxed element as well as an untaxed element. When a member gets a benefit, the super fund will calculate which part of the benefit will be tax-free and which part taxable. This will be based on the same proportion as the contributions that were paid to the fund (Australian Government, 2015g).

Tax on tax-free element

No tax will be payable on the tax-free element. This will be for concessional contributions. This will be regardless of the age of the members (Australian Government, 2015g).

If the member is younger than the preservation age

The preservation age is 60 if a member was born after 1 July 1964. This is the age at which members may access their super if they are retired. The following table will show the tax implications when a member receives a benefit before the preservation age:

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Table 5: Income tax implications of benefits when member is younger than preservation age

Type of super Type of withdrawal

Effective tax rate (including Medicare levy)

Taxable component – taxed

element Income stream Your marginal tax rate

element Lump sum

Your marginal tax rate or 22%, whichever is lower

Taxable component – untaxed

element Income stream Your marginal tax rate

element Lump sum

(Australian Government, 2015g) If a member is older than 60 years

If a member is older than 60 years and has therefore also passed the preservation age, the tax consequences of the benefits will be different. The following table will summarise the tax implications:

Table 6: Income tax implications of benefits when member is 60 years or older

Type of super Type of withdrawal

Effective tax rate (including Medicare levy)

element Income stream No tax

element Lump sum No tax

element Income stream

Your marginal tax rate less tax offset of 10%

element Lump sum

(Australian Government, 2015g)

As the benefits are taxed at the marginal rate, the income tax rates will be the following for the 2015 – 2016 year of assessment (Australian Government, 2015h):